There is less novelty, either in the course of the argument or
in the results achieved, in the Rate of Interest(1*) than in Mr
Fisher's earlier volume on the Nature of Capital and Income. Substantially
the whole of it lies within the accustomed lines of that marginal-utility
school of economics for which its author has so often and so convincingly
spoken. It is true to the canons of the school, even to the point
of making the usual error of logic in the usual place. But while
it makes no material innovation, beyond a new distribution of
emphasis among the factors held by the school to determine the
rate of interest, it carries out the analysis of these determinants
with unexampled thoroughness and circumspection, such, indeed,
it may fairly be hoped, as will close the argument, on the main
heads of the theory at least, within the school. There is all
the breadth and facility of command over materials, which Mr Fisher's
readers have learned to expect, such as to make the book notable
even among a group of writers to whom such facility seems native.
If fault is to be found with this exposition of the marginal-utility
doctrines it is scarcely to be sought in details of fact or unauthorised
discrepancies of logic. Exception may be taken to the argument
as a whole, but scarcely from the accepted ground of the marginal-utility
school. Nor should that remnant of the classical school which
has not yet given its adherence to the marginal-utility doctrines
readily find fault with an exposition which finds its foundations
in so good and authentic a utilitarian theorist as John Rae.

The theory of interest arrived at is the so-called "agio"
or discount theory, already familiar to Mr Fisher's readers and
substantially in accord with the like theory spoken for by Böhm-Bawerk.
Mr Fisher takes issue with Böhm-Bawerk on the one grave and
far-famed point of doctrine concerning the "Roundabout Process".
And on this head, I apprehend, it will be conceded that the later
writer occupies the stronger and more consistent position, whatever
exceptions may be taken to his line of argument in refutation
of the doctrine in dispute. In his critical survey of competing
and inadequate interest theories, occupying the first four chapters
of the volume, this doctrine of the roundabout process comes in
for more serious attention than all the rest; and justly so, since
it is an alien in the school -- a heresy which has been brought
in by oversight. Leaving on one side for the moment all question
as to the merits of this doctrine, it may readily be shown not
to belong in the same explanation of interest with the agio theory,
at least not as a proposition correlative with the theorem about
the differential preference for present over future income. Interest
and the rate of interest is a matter of value, therefore to be
explained in terms of valuation, and so in terms of marginal utility.
with the scheme of value theory for which Mr Fisher and Böhm-Bawerk
are spokesmen no analysis of a value phenomenon can be brought
to a conclusion until it is stated in terms of marginal utility.
All fundamental proposition, all theorems of the first order in
this theoretical scheme must be stated in these terms, since these
terms alone are ultimate. Facts of a different order bear on any
question of value, in this scheme, only as they bear on the process
of valuation, which is matter to be stated in terms of marginal
utility. This scheme of theory is a branch of applied psychology
-- of that school of psychology which was in vogue in the early
nineteenth century; whereas the roundabout process is not a psychological
phenomenon -- at least not of the same class with the doctrines
of marginal utility. It is a technological matter. The roundabout
process has a bearing on the rate of interest, therefore, only
as it bears on the main theorem concerning the preference for
present over future income; that is to say, the doctrine of the
greater productivity of the roundabout process is, at the best,
a secondary proposition, subsidiary to the main theorem. The
valuations out of which the rate of interest emerges take account
of various circumstances affecting the desirability of present
as contrasted with future goods; among these circumstances may
be the greater productivity of the roundabout process; but this
is as near to the core of the problem as that phenomenon can be
brought. The problem of the rate of interest in the marginal-utility
system is a problem of applied psychology, more precisely a problem
of the hedonistic calculus; whereas the alleged greater productivity
of the roundabout process is a technological phenomenon, an empirical
generalisation concerning the mechanical efficiency of given industrial
ways and means. As an explanation of interest the doctrine of
the roundabout process belongs among the productivity theories,
as Mr Fisher has indicated: and as such it cannot be admitted
as a competent, or indeed a relevant, explanation of interest
in a system of theory whose purpose is to formulate a scheme of
economic conduct in terms of the hedonistic calculus.

It is quite conceivable that in some other system of economic
theory, worked out for some other purpose than the hedonistic
explanation of value, the roundabout process might be brought
into the central place in a doctrine of interest; but such a doctrine
would have as its theoretical core, upon which the theorist's
attention should be concentrated, the physical production of that
increment of wealth that is presumed to go to interest, rather
than the pecuniary determination of the rate of interest through
which this increment is distributed among its claimants. Such
a doctrine would belong in a theory of production, or of industry,
not in a theory of distribution, or of business. But the marginal-utility
system is primarily a theoretical scheme of production; and, therefore,
in so far as it is or aims to be primarily a theory of business
traffic, not of the processes of industry, particularly not of
technological efficiency or of technological changes. This is
well shown, e.g., in Mr Fisher's discussion of invention (ch.
x, ch. xi, sec. 4, ch. xvii, sec. 6).

Apart from all question of consistency or conclusiveness within
the premises of the marginal-utility school, the test to which
Mr Fisher's theory of interest must finally be brought is the
question of its adequacy as an explanation of interest in modern
business. Mr Fisher has recognised this, and the most painstaking
and most admirable portions of the volume are those which discuss
interest as involved in current business transactions (e.g., ch.
xii-xvi). In modern life distribution takes place almost wholly
in pecuniary terms and by means of business transactions. In so
far as it does not, e.g., in the distribution of consumable goods
within the household or in the distributive use of public utilities,
it does not bear sensibly on any question of interest, particularly
does it not bear immediately as a determinant on the rate of interest.
Interest, as demanding the attention of the modern economist,
is eminently a pecuniary phenomenon, and its rate is a question
of business adjustments. It is in the business community and under
the guidance and incitement of business exigencies that the rate
is determined. The rate of interest in any other bearing in modern
life is wholly subordinate and subsidiary. It is therefore an
inversion of the logical sequence when Mr Fisher, with others
of the school, explains pecuniary interest and its rate by appeal
to non-pecuniary factors. But such are the traditions of the school,
and such a line of analysis is imposed by their premises.

As has been remarked above, Mr Fisher's development of the doctrine
of interest is true to these premises and traditions to a degree
of nicety never excelled by any of the adepts. These premises
or postulates on which the marginal-utility scheme rests are derived
from the English classical economists, and through them from the
hedonistic philosophy of the earlier decades of the last century.
According to the hedonistic postulates the end and incentive is
necessarily the pleasurable sensations to be derived from the
consumption of goods, what Mr Fisher calls "enjoyable income"
or "psychic income" (see Glossary, pp. 339-340), and
for reasons set forth in his analysis (ch. vi), it is held that,
on the whole, men prefer present to future consumption. This is
the beginning of economic (marginal-utility) wisdom; but it is
also the end of the wisdom of marginal utility. To these elemental
terms it has been incumbent on all marginal-utility theorists
to reduce their formulations of economic phenomena. And from the
acceptance of these limitations follow several characteristic
excrescences and incongruities in Mr Fisher's theory, presently
to be spoken of.

To save argument it may be conceded that the hedonistic interpretation
of human conduct is fundamentally sound. It is not requisite for
the purpose in hand to discard that postulate, however frail it
might prove on closer scrutiny. But if it be granted that the
elemental motive force of economic life is the hedonistic calculus
it does not follow that the same elemental calculus of preference
for present over future sensations of consumption is to be directly
appealed to in explanation of a phenomenon so far from elementary
as the rate of interest. In point of historical fact anything
like a consistent rate of interest emerges into the consciousness
of mankind only after business traffic has reached some appreciable
degree of development; and this development of business enterprise
has taken place only on the basis and within the lines of the
so-called "money economy", and virtually only on that
higher stage of the money economy specifically called a "credit
economy." Indeed interest is, strictly, a phenomenon of
credit transactions alone. But a money economy and the consequent
credit transactions which give rise to the phenomena of interest
can emerge only on the basis afforded by the mature development
of the institution of property. The whole matter lies within the
range of a definite institutional situation which is to be found
only during a relatively brief phase of civilisation that has
been preceded by thousands of years of cultural growth during
which the existence of such a thing as interest was never suspected.
In short, interest is a business proposition and is to be explained
only in terms of business, not in terms of livelihood, as Mr Fisher
aims to do. Business may be intimately concerned with livelihood,
it may even be that in modern life business activity is the sole
or chief method of getting a livelihood, but the two are not convertible
terms, as Mr Fisher's argument would require; neither are business
gains convertible with the sensations of consumption, as his argument
would also require.

The reason why these terms are not convertible, and therefore
the reason why an argument proceeding on their convertibility
or equivalence must reach a fallacious outcome, is that a growth
of institutions intervenes between the two -- granting that the
hedonistic calculus is the primary incentive and guide of economic
activity. In economic life, as in other lines of human conduct,
habitual modes of activity and relations have grown up and have
by convention settled into a fabric of institutions. These institutions,
and the usual concepts involved in them, have a prescriptive,
habitual force of their own, although it is not necessary at every
move to ravel out and verify the intricate web of precedents,
accidents, compromises, indiscretions, and appetites, out of which
in the course of centuries the current cultural situation has
arisen. If the contrary were true, if men universally acted not
on the conventional grounds and values afforded by the fabric
of institutions, but solely and directly on the grounds and values
afforded by the unconventionalised propensities and aptitudes
of hereditary human nature, then there would be no institutions
and no culture. But the institutional structure of society subsists
and men live within its lines, with more or less questioning,
it is true, but with more acquiescence than dissent.

Business proceeds on the ground afforded by the institution of
property, more particularly of property as rated in terms of money
values. The rate of interest is one of the phenomena involved
in this business traffic, and its theoretical explanation must
run in terms of business, and so in terms of money. When the question
is removed from this institutional basis and is pushed back to
the grounds on which property and money are conceived to rest,
it ceases to be a question of interest and becomes a detail of
the analysis of the phenomena of value. But value, as understood
by living economists, has no existence apart from the institution
of property -- since it is concerned with the exchange of property.
Interest is a pecuniary concept having no validity (except by
force of an ambiguity) outside of the pecuniary relations of the
business community, and to construe it in other, presumably more
elementary, terms is to explain it away by dissolving it into
the elements out of which it is remotely derived, or rather to
which it is presumed to be remotely related. The phenomena of
modern business, including the rate of interest, can no more be
handled in non-pecuniary terms than human physiology can be handled
in terms of the amphioxus. The difference is that between explaining
current facts and endeavouring to explain them away.

There is (probably) no science except economics in which such
an endeavor to explain the phenomena of an institution in terms
of one class of the rudiments which have afforded the point of
departure for the growth of the institution would be listened
to with any degree of civility. The philologists, for example,
have various infirmities of their own, but they would have little
patience with a textual critic who should endeavor to reduce the
Homeric hymns to terms of those onomatopoetic sounds out of which
it is presumed that human speech has grown. What fortune would
have overtaken E.B. Tylor's Researches into the Development of
Mythology, Philosophy, Religion, Language, Art and Custom, if
he had set out to explain away the facts and show these institutions
are of no effect because he knows something about the remote sources
from which they have come? Scientific vagaries of that heroic
stature are not unknown among ethnologists, but it is to be noted
to the credit of the craft that they are know vagaries.

Mr Fisher's theory of the rate of interest suffers from the same
oversight of this difference between explaining facts and explaining
them away, as do the common run of marginal-utility doctrines.
So, since interest is to be formulated in terms of consumptive
hedonism, instead of in business concepts, and since price is
to be formulated in the same terms, there arises an unavoidable
confusion between the two, as appears in the discussion of "Appreciation
and Interest"( ch. v, and elsewhere). In the main, this discussion
belongs properly in a theory of prices. Appreciation and depreciation
of the standard of payments may of course -- so far as they are
foreseen -- affect the rate of interest; but they are, after all,
phenomena of price. Business transactions run in terms of money.
Interest is rated in money and paid with a view to money gain.
Many contingencies bear on the changes of such gain, and changes
of price are notoriously among those contingencies. Speculative
buying and selling look to this contingency chiefly, and may look
to such a change in the price of the goods bought or sold as shall
offset the interest on the funds tied up in the speculation, but
the rate of interest does not thereby come to be conceived or
stated in terms of the advance or decline of the price of goods.
Appreciation and depreciation, if foreseen, are circumstances
to be taken into account by lender and borrower very much as the
productivity of the roundabout process (if that doctrine be allowed)
will be taken into account in making the rate of interest. But
this state of the case does not make either of these phenomena
a rate of interest; nor does it reduce interest to a technological
matter on the one hand or to a variation of prices on the other
hand.

Now and again, especially in ch. xiv (pp. 276-285), Mr Fisher
cites facts showing that neither investment nor interest are counted
in terms of livelihood or in the sensations of consumption, and
showing also that questions of livelihood touch these phenomena
only uncertainly and incidentally. He well shows (a) that business
men habitually do not (adequately) appreciate variations in the
commodity-value of money, and (b) that with rising prices they
simply do business at a high money profit and are content to pay
a high rate of interest without suspecting that all this has any
connection with the "commodity interest" of Mr Fisher.
(Cf. the passages cited from Baxter and from Jevons). But his
hedonistic preconceptions lead him to take note of this state
of things as exceptional and anomalous, whereas, of course, it
is the rule. It is not only the rule, but there is no avoiding
it so long as business is done in terms of money, and in the absence
of a foregone conclusion these facts should persuade any observer
that money value has an institutional force in the counsels of
business men.

This chapter (xiv), and in good part the succeeding one, explain
interest without support from or reference to Mr Fisher's "agio"
theory, although they are offered as an "inductive verification"
of that theory. Except for the author's recurrent intimations,
nothing in this inductive verification bears on, or leans on,
the doctrine of a preference for present over future income. Not
only so, but chapter xiv, incidently helped out by various passages
elsewhere, goes far to disprove that the rate of interest is a
matter of the preference for present over future income, taking
"income" in Mr Fisher's sense of the term. There is
a strikingly ingenuous passage in ch. xv, (p. 315): "For
him [the farmer] the lowest ebb is in the fall, when gathering
and marketing his crops cause him a sudden expenditure of labor
or of money for the labor of others. To tide him over this period
he may need to borrow... The rate of interest tends upward."
The farmer, in other words, bids up the rate of interest when
his crops are in hand or are coming in; particularly just after
he has secured them, when he is required to meet certain pecuniary
obligations. But the farmer's crops are his "income"
in the case assumed, and when his income has come in, at this
springtide of his income stream, his preference for present over
future goods should logically be at its lowest, and, indeed, there
need be little question but such is the case. There is also no
doubt that the farmer is willing to bid high for funds at this
period; and the reason seems to be that then the fresh access
of income enables him to bid high, at the same time that he needs
the funds to meet pecuniary obligations. His need of borrowing
is due to the necessity of marketing his crops and so "realising"
on them; that is to say, it is a business or pecuniary need, not
a matter of smoothing out the income stream. Farming is a business
venture in modern times, and the end of business is gain in terms
of money. The cycle of business enterprise closes with a sale,
a conversion of "income" into money values, not conversely,
and the farmer is under more or less pecuniary pressure to bring
this pecuniary cycle to a close.

NOTES:

1. The Rate of Interest: Its Nature, Determination and Relation
to Economic Phenomena, By Irving Fisher, New York, 1908.